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How You're Doing Your Retirement Wrong

Written by: MainStreet08/05/13 - 4:46 PM EDT

By Liam Fox

NEW YORK (MainStreet)--Amid pervasive skepticism about standard 401(k) accounts in light of hefty management fees and low yields, some folks are getting hip to the value of low-cost index funds and classic pension plans.

This question has been the subject of heated debate lately, with some experts contending that the creation of these retirement accounts unfairly shifted the burden of investment management to those who are least qualified for the task - ordinary employees. Because of their inexperience, many employee retirement fund "investors" are losing tens of thousands of retirement dollars by filling their accounts with costly, actively-managed mutual funds. However, many individuals are recognizing the importance of educating themselves about investments, and are taking on the job of actively managing their own retirement accounts. This represents a sea change that is threatening a major source of revenue for the investment community.

Index-fund guru John C. Bogle, founder and former CEO of Vanguard Group, Inc., claims that fees charged by managed mutual funds are eating away at retirement accounts, reducing the likelihood that employee retirement savings will ultimately be adequate. Bogle recommends that individuals invest their 401(k) accounts in low-cost index funds, such as those offered by Vanguard. But this is not just self-serving advice - it's a matter of simple math. According to an April 23, 2013 Frontline report on "The Retirement Gamble," actively-managed funds charge average annual fees of 1.3% compared to 0.2% for index funds. This means that, over the course of a career, investment fees can cost an ordinary employee more than $100,000- a huge amount considering that the average 401(k) balance reached a "record" of $74,900 in the first quarter of 2011.

For so many American workers to willingly part with $100,000, they must believe that mutual fund managers do a lot better job of investing than they could. Certainly the banks, brokerages, insurance companies and other financial service firms who offer mutual funds do a great job of touting their expertise.

Unfortunately, that expertise generally doesn't translate into better returns. A 2012 report by Standard and Poor's concluded that managed funds outperformed indexes over the prior five years in only one out of seventeen investment categories. Likewise, Mark Kritzman, an MIT senior lecturer in finance who is also CEO of an investment management company, found that over 20 years an index fund's average 8.5% after-expense return would beat out both an actively-managed fund with an annualized return of 10% and a hedge fund earning 19%.